Rule of the iron rooster

On track: workers finish a Wuhan rail link that creates Asia’s biggest marshalling yard. The network is about to eclipse that of India

Under the leadership of the Communist Party, the people in China brace up to cope with the financial crisis and have scored marked successes to the worldwide attention. High-level figures from the western political and economic spheres … envy China’s superb performance … as well as “China’s spirit”– the kind of solid, unbreakable “Great Wall” at heart to ward off the financial crisis.

– English-language editorial in the People’s Daily, official mouthpiece of the Communist party of China, July 30

China’s rulers can be excused a modicum of less-than-grammatical gloating after the economic rebound the country has achieved in recent months. With its quick and overwhelming response to the crisis, Beijing appears to have engineered a powerful V-shaped recovery and by most estimates is on track to exceed the 8 per cent growth target it set at the start of the year.

Official readings of industrial production, fixed investment, power consumption and gross domestic product all show a strong revival, while equity and property prices have soared in recent months. There have even been signs of a recovery in exports, although these are still about one-quarter below the levels of a year ago.

But a growing number of economists and officials say the positive growth data hide worrying structural imbalances and the government’s response to the crisis may only have postponed an inevitable reckoning. With the world looking to China as a beacon to lead the way out of economic gloom, a second downturn would have a big impact on global confidence, not to mention commodity prices.

“There is such a thing as good 5 per cent growth and bad 8 per cent growth,” according to one senior adviser to the government. “We worry that what we’re seeing falls more into the latter category.”

On an annual basis, China’s economy grew 7.9 per cent in the second quarter, well up from 6.1 per cent in the first quarter. If measured sequentially the rebound was even more obvious, economists estimate, with seasonally adjusted quarter-on-quarter growth at zero in the fourth quarter of 2008 but picking up to 3 per cent in the first three months of this year and as much as 16-17 per cent in the second quarter.

This was thanks largely to the government’s Rmb4,000bn ($585bn, €409bn, £355bn) fiscal stimulus and the Rmb7,370bn of new bank loans extended in the first half of the year, triple the amount lent in the same period a year earlier. Economists at BNP Paribas estimate that the loan expansion was equivalent to 45 per cent of half-year GDP and say they know of no other economy that has created credit on such a scale since the second world war.

This lending boom, carried out by the country’s state-controlled banks on the orders of the central government, has raised concerns that much of the money has gone to borrowers who will not be able to pay it back. “I worry what’s happening now is similar to what happened in the US in 2001 – the government is flooding the economy with cash that just ends up papering over the problems,” says a Chinese corporate executive who used to live in the US.

Royal Bank of Scotland analysts say around 20 per cent of new loans in the first half may have found their way into the equity market and another 30 per cent into property and other financial assets, helping to inflate unsustainable asset bubbles.

“The property market is so hot right now and prices are going up so much that it really is a seller’s market,” says Wang Qing, a driver earning Rmb2,500 a month who has started speculating on real estate by buying and selling small apartments in his spare time. “The sales agent told me the other day I had to fly to Hong Kong to meet the seller of one apartment just to show I was sincere, because there were too many other bids out there.”

China’s stock market is up 64 per cent this year but has dropped 14 per cent in the past three weeks as investors panicked over signs the government was starting to rein in excessive loan growth. Analysts say the steep drop shows how much of this year’s rise has been fuelled by bank loans channelled into speculative activity.

“Everyone privately thinks this is an asset bubble driven purely by liquidity,” says a senior executive at a Chinese investment bank. “Those in the private sector who have been able to get loans from the state banks are mostly keeping it for a rainy day or speculating on the stock and property markets; very little is going into the real economy.”

Of the rest that has gone that way, the bulk has been to state companies and government-backed infrastructure projects, particularly the tiegong­ji or “iron rooster” – a homonym for the Chinese words for rail, roads and airports. The huge projects have revived demand for steel, concrete and other raw materials but this kind of capital-intensive state investment creates relatively few jobs. Yet over the next three years, the railways ministry plans to add 20,000km of track to the existing 80,000km, with a total investment of more than Rmb2,000bn. At this rate, China’s rail network will this year overtake that of India to become the second-longest in the world, behind the US.

As for roads, construction began in the first half on 111 expressways totalling 12,000km with an investment of Rmb700bn, according to the ministry of transport. By the end of last year China had just over 60,000km of high-speed roads, compared with 75,000km in the US. But if plans by local governments are included, China’s high-speed road network would expand to 180,000km in the next few years, an astounding figure considering China has only 38m passenger vehicles against 230m in the US.

Some officials say the most worrying element of the infrastructure-heavy stimulus package is the fixation with building airports. For instance, the town of Jiaxing in eastern Zhejiang province is roughly an hour’s drive on brand new expressways from three of the country’s busiest international airports – two in Shanghai and one in the city of Hangzhou. In spite of this proximity, and a planned high-speed rail line connecting Shanghai and Hangzhou, the Jiaxing government has decided to build a commercial airport on the site of a military landing strip, with an estimated investment of Rmb300m.

Jiaxing officials say they expect to recoup their money by 2025 but sceptics say this kind of investment will never repay itself and will instead end up as a bad loan on the books of the state banks. “The main concern we have now is that a tremendous volume of loans was extended very rapidly to the corporate sector at a time when corporate profitability was declining,” says Charlene Chu at Fitch Ratings. “That would suggest there will be some significant asset quality problems down the road.”

While state-owned enterprises have been inundated with loans from the state banks, economists worry too that China’s vibrant private sector has been largely left to fend for itself.

“The fiscal and monetary policy response to the crisis has mostly benefited the largest enterprises and biggest projects,” says Wang Yijiang, professor of economics and human resources management at the Cheung Kong Graduate School of Business in Beijing. “The small and medium-sized enterprise sector provides 75 per cent of the jobs to China’s urban workforce but now it is shrinking for the first time in 30 years of economic reforms.”

Aged 42, Chen Guangming has spent half his life as a migrant worker in China’s big northern cities but at the end of last year became one of an estimated 23m who lost their jobs and returned home to the villages. “This year it is much harder to find work and I spent most of the year waiting in my village until some relatives told me about this job,” he says, indicating the construction site where he is paid Rmb70 for a 10-hour day.

The latest 6.1m graduates from Chinese universities have also been struggling to find work. The education ministry says 68 per cent have been employed so far but independent estimates put the number at only around 50 per cent. More than 1.5m of last year’s graduates are also still searching for work.

At a talent fair next to Beijing’s ancient Lama Temple, 24-year-old Peng Chuan, who graduated with a degree in English in July 2008, has lowered his sights and is looking for work as a waiter. “Salaries in the private sector have fallen so much but some of my classmates managed to get jobs in the government by leveraging their family connections,” he says.

Competition is fierce these days and landing a secure post requires many to pull strings or offer inducements to those who vet the applicants. “I had a chance to work in a bureau at the railway ministry but I would have had to pay Rmb100,000 to get the job and my family couldn’t afford that,” adds Mr Peng.

While official figures show steady income growth and rising consumption, many economists say these numbers are unreliable because they are heavily weighted towards state-sector salaries and government procurement. Incomes and private consumption are likely to be growing weakly if at all, they say, making it harder for domestic consumption to compensate for the large drop in exports.

They worry that when the effect of the stimulus recedes and Beijing reins bank lending back in, economic imbalances will re-emerge and the government could face another crisis. “It is too early to say that China’s recovery is a V-shaped one,” says Cheung Kong business school’s Prof Wang. “There are many people who truly believe the economy will face another big slide and the recovery will look more like a W.”

‘It is hard to compete if playing against the referee’

When Huang Guangyu, China’s richest man, was arrested late last year, he was accused of manipulating the share prices of two of his companies. But according to people familiar with the Chinese security services, his real crime was building an empire that included Hong Kong-listed Gome, the country’s largest electronics retailer.

Detained: Huang Guangyu, China’s richest man

These people say some in the Chinese leadership felt Mr Huang had grown too powerful and his business too important to the national economy for it to be left in his hands. If true, this case is just the sharp end of a wider phenomenon known commonly as guojinmintui, or “the state advances as the private sector recedes”.

Leaders have repeatedly denied that the government is implementing a policy of renationalising parts of the economy and most analysts agree there is no formal policy to support guojinmintui. But some argue that the government’s response to the financial crisis has allowed state-owned enterprises, which are often controlled by powerful political families and already monopolise the commanding heights of the economy, partially to reverse the privatisation that has occurred in China over the last 30 years of economic reform.

“Large parts of the economy seem to be increasingly dominated again by state-owned enterprises,” says Dan Lynch, a professor of international relations at the University of Southern California US-China Institute. “This is a long-term problem but it has been exacerbated by the financial crisis and the failure of large numbers of privately owned small and medium-sized enterprises.”

Prof Lynch points out that China’s enormous credit-fuelled economic rescue plan has been focused on supporting the state sector and government-backed infrastructure projects, leaving many smaller private companies to go under, even though they make up the most dynamic part of the economy and provide the most jobs.

Large state enterprises with easy access to credit have this year swallowed up private competitors in sectors from airlines to beauty products. In Shandong province, the local government has engineered a hostile takeover that will see the profitable, privately held Rizhao Steel absorbed by Shandong Steel, a lossmaking state rival, as early as Tuesday, according to Chinese media.

“Since the current administration took over seven years ago, there has been a real backlash against development of the private sector and that is now accelerating,” observes a senior Chinese banker. “It’s quite hard to compete when you’re playing against the referee.”

Analysts say struggling, privately owned petrol stations are being rapidly acquired by state monopolies such as PetroChina, while many private real estate developers are unable to compete with well-funded state giants who are driving up land prices across the country.

In his book A Century of Ebb and Flow, author Wu Xiaobo argues that entrepreneurs’ problems pre-date the founding of the Communist party 60 years ago. Under the Qing emperors and the Nationalists who succeeded them, he says, the economy was always dominated by state enterprises and that any time a private company became too big or successful its owner was removed and it was gobbled up by a state competitor.

“An authoritarian, centralised state cannot tolerate alternative centres of power,” says one well-connected Chinese businessman. “Until we have meaningful political reform in China, we’ll never be able to overcome these issues and our economy will not be able to move on to the next stage of development.”